TMCNet:  CHINA'S INNOVATION GAP [Mechanical Engineering]

[January 16, 2013]

CHINA'S INNOVATION GAP [Mechanical Engineering]

(Mechanical Engineering Via Acquire Media NewsEdge) When China looks in the mirror, it sees little intellectual property behind its manufacturing muscle. Can it do something about it Where is China's George Westinghouse Or its Steve Jobs or Henry Ford It is a question few outside China ever ask. After ail, in less than 20 years, China has transformed itself from a technology backwater into the world's leading manufacturer. Its factories churn out low-cost clothing and toys, and also high-tech smartphones, tablets, and televisions. Fifteen years ago, it was a nation of bicycles; today, it is the world's largest producer of automobiles.


From the outside, we see a manufacturing juggernaut. When China's leadership looks in the mirror, it sees an economy whose future success is far from assured.

To understand why, consider Apple's iPhone. It is assembled in vast Chinese factories with modern infrastructure. The iPhone's factory price is $144. Apple's wholesale price is $224.

Yet Chinese manufacturers receive only $3.86 per unit for assembly and testing. Apple's vendors, which supply such components as the processor and display, receive another $14.14.

That means Apple earns $126 on each iPhone leaving the factory, plus most of the $80 markup to the wholesale price. As a percentage of the iPhone's wholesale price, Apple's component vendors receive about 10 percent and its Chinese manufacturers less than 2 percent.

A similar survey shows China receives only 1.7 percent of the retail price of Hewlett-Packard computers.

This is China's weaknesses: It earns only pennies on the retail dollar for the products it makes. The companies that own the intellectual property retain most of the value.

Manufacturing has taken China very far in only a matter of decades. Yet the clock is ticking. C" cannot count on low wages forever.

According to a recent study by the Boston Consulting Group, Chinese workers have been averaging 15 to 20 percent wage increases annually. In the heavily industrialized Yangtze River region, pay is roughly $3 per hour, compared with 72 cents in 2000.

Boston Consulting predicts it could reach $6.30 per hour by 2015. While that is one-fourth the pay of average U.S. or German factory workers, automation makes those workers far more productive than their Chinese counterparts.

As Chinese wages rise, workers in the United States, Germany, Japan, Korea, Italy, and other nations that have automated will increasingly compete with China on a more level playing field.

To thrive, China must produce and support creative people like Steve Jobs- and Henry Ford, Thomas Edison, and George Westinghouse- whose innovations will enable China to create greater and broader wealth beyond its manufacturing sector.

China's leadership knows it can no longer be simply a factory to the world. To thrive in the future, China needs to build on its brains, not its brawn. It needs to transform itself into a knowledge economy that generates innovation. But how INNOVATION NETWORKS To understand China's plight, consider the three trends that powered the nation's rapid economic growth. Between 1985 and 1995, China encouraged foreign corporations to build factories and take advantage of low-cost labor. Starting around 1995, the government underwrote the rapid growth of Chinese businesses with low-cost capital.

By 2005, however, much of China's growth in high-tech products was still being driven by copying and reverse engineering intellectual property developed by others. This created friction with other nations and their innovative corporations. It has also stifled the development of home-grown intellectual property, since Chinese innovators can never be sure they will profit from their ideas.

China's leaders understand this conundrum. They want to encourage greater innovation, so Chinese companies can capture a greater share of the wealth their manufacturers create.

The central government has laid the groundwork for a more innovative economy. A series of mediumto-long-term initiatives are funding science and technology research, reforming education, developing talent, and supporting emerging industries.

The results are mixed, but show signs of China's progress over the past two decades. The country has increased science and technology funding significantly. According to an annual study by Battelle and RâD magazine, China's share of global R&D spending was 13 percent in 2011, compared with 34 percent for the United States, 23 percent for Europe, and 12 percent for Japan.

Enrollment in higher education has expanded, and the quality of programs and facilities has improved. China leads the world in science and engineering graduates, though there are still shortages of the right mix of talent and skills even among high quality graduates.

Chinabas made some progress on intellectual property rights. It puts increasing emphasis on standards. It has tried to reverse the "brain drain" and entice expatriate Chinese professionals to return home. Native venture capital firms are starting.

Yet China cannot do this alone. In our globalized world, knowledge, talent, and innovation are increasingly mobile. No one corporation or nation can keep pace- much less lead-in idea creation by itself.

China's leaders appear to grasp this, and want to embed their nation into transnational R&D networks that now extend beyond the United States, Europe, and Japan. In these increasingly far-flung confederations of multinational corporations, universities, and national laboratories, knowledge flows in multiple directions.

By embedding itself in these knowledge networks, China hopes to teach a new generation of innovative Chinese thinkers to jumpstart its own innovation extravaganza.

China has created an extensive network for acquiring technology through international cooperation. It includes: * Growing numbers of foreign R&D centers and technical experts in China.

* Rising participation in international scientific, technology, and standards-making organizations.

* Increased numbers of students and scholars abroad, and cultivation of links with Chinese professionals overseas and in Taiwan.

* Bilateral research and technology transfer agreements.

* Encouragement of foreign investment in manufacturing and R&D.

With all this know-how flowing into China, the nation has boosted exports of high-tech products and more than halved its reliance on foreign technology.

It sounds like a success story, yet the key question Chinese leaders keep asking themselves is, "Who owns the IP " Clearly, Hu Jintao, president of China and former general secretary of the Communist Party, is concerned. In a 2010 speech he told the Chinese Academy of Sciences: "Thanks to efforts made over a long time, our country has made rapid progress towards our science and technology goals. But our capability to make independent innovation is still not great. The overall technology content of economic development is not high; many crucial and core technologies are still under the control of others; the strength of our science and technology in leading strategic advanced technologies is weak; and the reliance of important industries on foreign technology is still very high." China's experience with Apple's iPhone tells only part of the story. Consider, for example, high-tech exports.

In 2010, foreign-owned companies accounted for more than 60 percent of China's high-tech exports. Joint ventures between multinationals and Chinese companies amounted to somewhat less than 20 percent. State-owned factories provided another 10 percent. That left wholly owned Chinese firms with less than 10 percent of total exports.

Moreover, 70 percent of the value China adds to high-tech exports comes from assembling or processing imported goods, and as we have seen with the Apple iPhone, this is very low value work.

PRIMING THE RESEARCH ENGINE China has made enormous strides over the past decades. It has begun to embed itself in global knowledge networks. But how does it make the leap to innovation I believe foreign R&D centers will play a central role in Chinese innovation.

The growth of multinational R&D centers in China has been explosive. In 1997, only 24 foreign R&D centers had registered with the Ministry of Commerce. That rose to 750 in 2005 and more than 1,300 in 2011.

These are not the old-style "the government forced us to do it" entities. This is a serious effort by large companies to tap the enormous- and relatively inexpensive- Chinese talent pool. Increasingly, these units are not simply there to reengineer products designed elsewhere to local requirements. Many now have regional and global responsibilities.

There are many reasons this happened over the past decade. Corporations have moved to China to take advantage of its growing science and engineering infrastructure and bright, high-quality engineers. Also, they must be in China if they want to have access to China's vibrant markets, manufacturing capabilities, and export-oriented tax policies.

These research centers are training a new generation in such critical, if often intangible, skills as managing projects and personnel, working on teams, adopting best practices, setting standards, and protecting intellectual property. They demonstrate how to establish an environment that supports creativity and innovation.

Some foreign research centers will have profound impacts outside their doors. Many have begun to partner and collaborate with local universities, government agencies, and corporate laboratories. They may generate spinoffs, or work with suppliers to improve productivity and quality.

Moreover, these skills are likely to circulate. As Taiwan's experience shows, many locals leverage their multinational experience to start enterprises of their own.

To achieve these results, research centers must confront a variety of talent and skills issues. As Fabian Jintae Froese of Korea University, a wellknown investigator of Asian research organizations, noted in 2010, multinational enterprises "are suffering from problems associated with recruiting and retaining highly qualified R&D professionals." People problems begin with new graduates. The competition for jobs is so intense, foreign research centers have been able to reduce starting wages for engineers and scientists. Fraudulent credentials have become a serious issue.

Most multinationals credit Chinese universities with providing new hires with a good basic education. Yet graduates show an absence of creative and critical thinking skills. They also lack such soft skills as teamwork, presentation, and conversational English needed to thrive as part of a transnational team.

Research centers looking for R&D managers face a different set of problems. Quite simply, there is a scarcity of real candidates.

This should come as no surprise. The real growth of foreign R&D centers in China began only eight years ago, and that is not long enough for firms to develop seasoned R&D leaders.

Multinationals set a high bar for R&D leadership. In addition to excellent engineering and research skills, candidates need a global rather than a China-centric perspective on their mission. They must be truly bicultural, and relate well with Chinese staff, headquarters, and units located in other countries. They must communicate well, if not fluently, in English.

Such people are hard to find. Rapid growth of information technology, telecommunications, and pharmaceutical R&D has exacerbated the problem.

Multinationals frequently raid one another for experienced R&D managers. While Chinese managers think compensation is important, they also look for learning opportunities, career advancement, and company brand. Moreover, 70 percent of applicants want to work in Beijing or Shanghai.

As a result, non- Chinese managers head more than half of all multinational R&D labs in China. On the other hand, the increased competition for qualified talent has forced laboratories to collaborate with universities in order to recruit qualified research leaders. This will ultimately help spread R&D management skills throughout the country.

Chinese leaders also hope to catalyze change by enticing top researchers to come to China. The Thousand People Plan, for example, seeks to recruit several thousand top entrepreneurs, managers, financiers, and especially scientists and engineers from abroad. It promises high salaries and generous government funding for laboratories.

While it is open to all researchers, its primary focus is on Chinese expatriates working abroad. The plan's architect, Politburo member Li Yuanchao, encouraged China's provinces and large municipalities to develop similar programs of their own.

The program has scored some successes, but many overseas Chinese are wary of making a full commitment. Instead, many run China-based laboratories, support students, and consult with companies either part-time or at a distance.

Their caution appears firmly grounded. Some returnees have received a mixed or icy reception from colleagues and have had to deal with jealousy, pushback, and other interpersonal issues.

Chinese multinationals are also reaching out to talented researchers in other nations by building research centers of their own overseas.

This is happening faster than you might think. In 2006, Chinese direct foreign investment overseas was $75 billion, about one-sixth the amount that multinationals invested in China. In 2009, it had grown to 50 percent of multinational investments, though this may be partly due to reduced spending following the 2008 global recession.

Still, many large Chinese companies are now firmly established overseas. Telecommunications companies Huawei and ZTE have research centers in Stockholm and Bangalore, and Huawei has additional units in Dallas, Moscow, and outside London. Electronics firms Galanz and Konka are in Silicon Valley. Haier is in Germany, Boston, South Carolina, and India. Foton Motors does R&D in Germany, Japan, and Taiwan.

CHINAS FUTURE China is working hard to become an innovator whose ideas and platform technologies capture the full value of its manufacturing infrastructure.

Yet a culture gap remains. In a January 2010 New York Times column, Thomas Friedman, author of The World is Flat, argued that there are two Chinese economies.

The first is "Command China." A child of the Communist Party's central planning mentality, it emphasizes stability and control. It is happy to mine existing IP through low-cost manufacturing, as long as it can curtail or suppress the flow of information for political reasons.

The second, "Network China," grew up with the booming coastal cities and is not necessarily or fully aligned with the Communist Party. It participates in global flows of diverse, high-value information. Its highly entrepreneurial firms design and innovate in intense fashion.

Command China innovates, but not in terms of ground-breaking technologies, Yinglan Tan explained in his 2010 book, Chinnovatìon:How Chinese Innovators Are Changing the World.

Star innovators in China, he wrote, are industrial evolutionists. They focus intensely on revenues, respond rapidly and agilely to changing conditions, and adapt to local requirements. Entrepreneurs draw on China's growing engineering talent, and seek to circumvent regulations and limits.

Yet those same entrepreneurs reverse engineer and copy from one another. They succeed by combining and remixing the best ideas of others.

That makes them a serious barrier to the growth of Network China, since innovators can never be sure they will profit from their hard work.

Chinese leaders understand that innovation is central to their criticai intereste. Without it, China will never capture the true wealth generated by its dynamic manufacturing sector, improve its competitiveness, or reduce its overall dependence on foreign technology. It will fail to capture the high ground in such emerging fields as life sciences and clean energy technology.

At the same time, leaders crave the stability and control Command China offers.

What will the future bring China has created the educational and research infrastructure needed to embed itself in emerging transnational knowledge networks. Thriving foreign enterprises are likely to have a significant impact on China's R&D culture.

Some of the technology developed in China will certainly stay in China, especially as R&D enterprises form closer links with Chinese universities and laboratories. If Taiwan is any indicator, Chinese with multinational experience are likely to become the technology entrepreneurs of China's future.

Yet most Chinese firms do not invest enough money in research. This is because it is easier to buy or copy technology than to innovate. This problem was the primary focus of a July 2012 national conference on science, technology, and innovation. At the conference, senior Chinese leaders acknowledged, in sometimes brutally frank fashion, the reality that China's innovation mechanisms need to be repaired. While these leaders are pressuring enterprises to innovate, it makes little financial sense unless officials are willing to tighten enforcement of IP rights.

Lack of R&D investment may be behind the leadership's new emphasis on "synergistic" as opposed to so-called "indigenous" innovation. It seeks to take advantage of China's extensive network for acquiring technology by combining knowledge resources, irrespective of origin, to spur the development of innovative products and services.

Will this new approach succeed Is it just another attempt- like foreign R&D centers, returned expatriates, and overseas research labs- to change China's R&D culture Can China truly create a knowledge economy that lives and breathes innovation The jury is still out.

Still, one billion people can accomplish a great deal when they put their minds to it. We certainly see signs of success, from manned space flights and a modernized military to record-setting highspeed rail and supercomputers.

Are these one-off advances- Potemkin technologies created to impress others- or signs of something more sustainable We will know the answer to that question when we see which Chinese firms become the next Apple, UP, Toshiba, Philips, or Siemens.

WE CERTAINLY SEE SIGNS OF SUCCESS, FROM MANNED SPACE FLIGHTS AND A MODERNIZED MILITARY TO RECORD-SETTING HIGH-SPEED RAIL AND SUPERCOMPUTERS.

DENIS FRED SIMON is the vice provost for international strategic initiatives at Arizona State University and held a similar position at University of Oregon. He has worked as a business strategy consultant in Asia, heading Accenture's and Monitor Group's China practices and Scient's East Asian operations. In 2006. Chinese Premier Wen Jiabao awarded him the China National Friendship Award in recognition of his extensive contributions to U.S.-China science and technology cooperation. He is a coeditor of Blobal R&D in China (Routledge, 2007) and coauthor of Chinas Emerging Technological Edge: Assessing The Role of High-End Talent (Cambridge University Press. 20091.

(c) 2013 American Society of Mechanical Engineers

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